New Capital Rules to Result in Higher Charges, Analysts Say

For most consumer and commercial asset-backeds, the new draft final rules for risk-based capital are expected to result in capital charges that are higher compared to those under Basel II.5 or III, according to Bank of America Merrill Lynch analysts in a recent report.

U.S. bank regulators have released a draft of the final rules on risk-based capital as it applies to market risk or as it covers “trading assets and liabilities”.

In terms of securitizations and re-securitizations, these rules provide a methodology for calculating “standardized specific risk capital requirements.” The specific risk pertains to changes in the market value of a position resulting from factors other than general market movements, reported BofA Merrill analysts.

Under the new rules, the methodology used includes a simplified version of the supervisory formula approach or SFA, which was part of Basel II's advanced capital adequacy framework. The new methodology is called the simplified supervisory formula approach (SSFA).

The SSFA takes away the dependency on credit ratings by substituting the internal ratings-based approach under Basel II.5 and Basel III as required by Section 939A of the Dodd-Frank Act.

As stated above, the draft version of the final rules would result in higher capital charges than those required under Basel II.5 or III.

Triple-A private student loan ABS, for instance, have a capital charge of 0.56% under Basel II.5, but have 1.6% under the final rule. Most triple-A rated securitized positions actually experience a similar magnitude of increase between the final rules and the capital charges under Basel II.5.

However, this does not apply to securitized positions that have relatively low credit enhancement levels such as prime auto and equipment loan ABS. The limited increase is also not true for product with high levels of impaired balances like FFELP ABS. For these exceptions, the capital charges under the draft final rule would not only be higher than those under Basel II.5, but also potentially higher than those that are backed by considerably riskier collateral types, BofA Merrill analysts said.

In a separate report, Amherst Securities Group (ASG) also weighed in on the SSFA approach, which analysts said did not address the loss mitigating features on these types of asset classes. However, analysts acknowledged that the final approach is a “ much more rational than a ratings-based approach, and represents a huge improvement over" the the Market Capital Risk Rules December proposal.”

ASG analysts took issue with three aspects of the new approach. They said that it does not consider structural features that effectively increase credit enhancement. These include structural characteristics such as overcollateralization and excess spread that offer extra enhancement and cash flow to a securitization trust.

Additionally, the purchase price or carrying value of a security is not covered. If a security is bought at a discount to par, that discount offers a certain level of cushion that absorbs losses. Analysts said this should be counted as credit enhancement and offer some capital relief.

They also think that the proposal is unfavorable to re-securitizations.ASG analysts acknowledged that regulators wanted to penalize complex structures. But, they noted that a different treatment should be given a simple resecuritization that is backed by one tranche or several tranches of a single transaction such as a floater and an inverse floater or two sequentials. In these deals, the cash flows on the re-REMIC could have been made in the context of the original offering and deserves the same capital treatment as it would have had it been configured in this manner from the onset.

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